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Treasury & Taxation

New Guidelines for 2018 Taxes Could Impact Corp Cash

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February 01, 2019

Whether GILTI provision will prompt repatriation remains an open question

IRS and dollarNew regulations aiming to clarify recent tax reform could significantly impact US companies’ cash. They also bring to light more fundamental issues that could alter corporates’ use of debt and diminish the law’s incentives to bring overseas earnings back to the US.

Since the Tax Cuts and Jobs Act was enacted in late December 2017, the US Treasury Department has issued more than 1,000 pages of guidance to clarify its many ambiguities. That language, much of it still in proposal form, often varies significantly from early guidance, leaving corporate tax with significant issues to resolve as the 2018 tax season approaches, and corporate treasury with short- and long-term issues to consider regarding cash.

With the 2018 tax season beginning April 15—although most corporates tend to file forms closer to October—one issue that will require the urgent tax attention and could significantly impact treasury’s cash management is new proposed regulations under Section 965. As enacted under the TCJA, it requires US companies that have historically deferred US taxation on overseas earnings to pay a one-time tax on those earnings in preparation for transition to the reform’s new territorial tax system. Payment of that tax can be spread over eight years. However, the final regulations, issued January 15 by the Treasury Department’s Internal Revenue Service (IRS), contain certain potentially significant differences from early interpretations of the law that companies used to file their 2017 taxes.

“There were certain surprises that may cause companies to go back and amend their 2017 returns and change some of those calculations,” said Marc Lim, a managing director in Andersen Tax’s commercial practice. “The whole process is more work from a compliance standpoint than I think corporate America, Congress or Treasury initially realized.”

Amending 2017 taxes according to the final rules could result in a bigger tax liability for that year, potentially crimping corporate cash. Mr. Lim noted that tax-liability payments over eight years would likely make it manageable.

“But some US companies have reported very significant tax liabilities on this, so even a small change over eight years on a large base could be significant,” he said.

Kathleen Dale, principal, international tax, at KPMG, said that some companies engaged in tax planning to reduce the amount of their 2017 repatriation taxes. However, the final regulations may allow the IRS to disregard certain transactions, and companies affected by these new rules are required to recalculate those taxes as if those transactions never occurred. This recalculation of the tax liability is required to be disclosed on the 2018 tax return.

In addition, she said, the original guidance permitted companies to estimate their cash balances to determine the cash positions to be repatriated, but the final regulations no longer permit estimates and require those numbers to be definitive, and that could be tricky. For example, a company may discover it had more cash than it originally thought, and because different rates apply to cash and noncash, its rate will go up. The updated cash balances would also have to be reported on the company’s 2018 tax return and could result in a change to the tax liability originally reported on the company’s 2017 return.

The IRS is permitting companies to pay the one-time repatriation tax in installments, but in return it expects the tax liability to be determined correctly. It put rules in place to disallow that deferral if the calculation proves to be incorrect, potentially resulting in a major tax wallop and the subsequent hit to corporate cash.

A more fundamental concern, according to Mr. Lim, is the new anti-tax-deferral provision referred to as the global intangible low-taxed income (GILTI) rules. Before tax reform, US multinational corporations (MNCs) could in many cases effectively defer taxes indefinitely if that income was permanently reinvested outside the US, a task typically handled by the treasury department. GILTI dramatically changes that strategy by taxing all or most international profits back in the US under a complex new set of rules.

A policy behind the provision is to incent companies to bring back earnings rather than invest them abroad, since via GILTI those international earnings are taxed regardless. Another element incenting them to bring back cash is tax reform’s new corporate rate of 21%, down significantly from the previous 35%, and as low as 10.5% if certain GILTI requirements are met.

“So, it gives companies greater ability and in theory desire to repatriate their international earnings,” Mr. Lim said, adding, “Now there’s a big question about whether the reality is achieving that goal. Is corporate America actually trending toward that objective? For the clients we’re working with, it’s still a very open question.”

One key element yet to be fully answered is avoiding double taxation instances, where taxes paid in foreign jurisdictions cannot be credited against US taxes levied on the same earnings. Under previous tax law, the point of taxation for US tax purposes was generally upon repatriation, allowing US companies to offset such tax via credits for foreign jurisdiction withholding taxes and other taxes. The new guidelines on how those foreign tax credits work in the GILTI regime, however, have yet to be fully published, and so now there’s the risk US companies could end up being double taxed—taxed in the foreign jurisdiction and in the US under GILTI, with no clear way to offset one against the other.

“When companies don’t understand the overall system of taxation, they’re often reluctant to make big changes to treasury or tax policy,” Mr. Lim said. He added that the issue becomes particularly problematic for companies with controlled foreign corporations (CFCs) in many Asian and Latin American jurisdictions that impose substantive withholding taxes on profit repatriation.

Even if the IRS fills in holes in the regulation, Mr. Lim said, whether the new rules change US companies’ behavior significantly remains an open question.

“Even with those questions answered, the regulation is going to result in mismatches, where MNCs are facing significant foreign tax costs to bring cash back without an ability to credit those costs against US taxes,” he said, adding. “So they could be disincentivized to actually repatriate cash.

Another potentially even longer-term issue for tax and treasury, Mr. Lim said, are rules under Section 163(j), since they limit the benefits of using debt by allowing the interest deduction to only reduce income up to 30% rather than the previous 100%. That’s a big deal for private equity firms whose strategies typically rely on that deduction, as well as profitable companies that today may find it advantageous to use debt over equity.

Mr. Lim noted that the change will become especially pronounced in a few years, when the earnings definition switches from EBITDA (earnings before interest, taxes, depreciation, amortization) to EBIT. Whether that changes companies debt issuance strategies over the next year or two, given debt maturities tend to be five years or greater, remains to be seen.

“I have not necessarily heard that it is the straw that breaks the camel’s back in terms of motivating corporate treasury to move to equity from debt,” Mr. Lim said. “But it’s a very real conversation going on now.”

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